On Friday, the Federal Reserve Board announced that it had denied the application by Custodia Bank to become a member of the Federal Reserve System. Custodia is a Wyoming state-chartered bank without FDIC insurance. The goal of the special purpose bank is to become a bridge between the digital assets sector and the U.S. dollar payments system.
Additionally, the Federal Reserve issued a policy statement proposing to extend crypto-asset restrictions to uninsured state chartered banks to put them on a level playing field with national banks and FDIC-insured banks.
All seven of the Federal Reserve Board members voted against providing Custodia with access to a master account.
Reasons for the Fed’s rejection include proposals for “novel and untested crypto activities that include issuing a crypto asset on open, public and/or decentralized networks.” Additionally, the Federal Reserve said Custodia’s risks management framework was ‘insufficient’ to address the elevated risks of crypto, especially AML.
About the application
The startup bank first applied to the Federal Reserve to have access to a Fed master account more than two years ago and has sued the Federal Reserve over the issue. Without a direct account, it has to go through intermediaries, adding a layer of costs that blockchain aims to address.
“Custodia offered a safe, federally-regulated, solvent alternative to the reckless speculators and grifters of crypto that penetrated the U.S. banking system, with disastrous results for some banks,” said Caitlin Long, Custodia CEO. “Custodia actively sought federal regulation, going above and beyond all requirements that apply to traditional banks. The Board’s denial is unfortunate but consistent with the concerns that Custodia has raised about the Federal Reserve’s handling of its applications, an issue we will continue to litigate.”
As a special purpose bank, Custodia customer deposits retain 100% backing as the bank is not allowed to advance loans. It also has its bank-issued digital dollar, Avit.
Given the FTX collapse, other crypto failures and volatility, the authorities are clamping down on the sector and attempting to keep the links between the crypto and banking sectors to a minimum.
However, Custodia’s founder Caitlin Long has a highly thoughtful approach to the sector. Since she launched Custodia in 2020, she’s been keen to provide a regulated path for the digital assets sector. Before her involvement in the crypto world, her resume included a nine years stint at Morgan Stanley, preceded by ten years at Credit Suisse.
In April Long commented, ““Bitcoin’s going to take a G-SIB (global systemically important bank) down at some point because they don’t understand that the settlement risk is so different between Bitcoin and traditional assets.”
Federal Reserve crypto proposals for uninsured state banks
Friday’s Federal Reserve publication was a draft policy statement. It aims to prevent state banks from holding most cryptocurrencies. With respect to stablecoins, banks would need a no-objection letter from the Federal Reserve and have sufficient controls in place.
From a legal perspective, the Federal Reserve can impose banking restrictions on nationally chartered banks. Because FDIC-insured banks have similar restrictions to national banks, any national bank restrictions also apply to them. The Federal Reserve says under the Federal Reserve Act it can impose discretionary limitations on state-chartered banks, and this is being used for crypto restrictions.
To date, two Federal Reserve member banks have had significant crypto exposures with both acting as significant on and off-ramps for the digital asset sector. The smaller Silvergate announced a $1 billion quarterly loss but managed to survive a massive drawdown in deposits from its digital asset customers. It also offered a range of services, including a limited amount of crypto-backed lending. Its stock price is just over a tenth of the figure compared to May 2022, before the crypto crash.
The larger Signature Bank was already quite diversified, but it recently announced it would reduce its exposure to the digital asset sector.
Source: Federal Reserve unanimously rejects application by crypto bank Custodia.